The Business Of

Movies | Disney | What Are Their Costs?

Morning All!

So, yesterday we covered a whole lot. Dissecting the many, many ways Disney makes their money. Let’s have a quick recap of how much their main revenue segments contribute…

1. Disney Parks and Experiences - 34% of revenues. This revenue comes from park admissions, selling food and drink, and merchandise licensing!

2. Linear Networks - 33%. This revenue is made up of affiliate fees and advertising that Disney makes from their ESPN, ABC, Disney channel networks.

3. Streaming - 23%. Predominantly subscription fees for Disney+, Hulu and ESPN+. With some advertising thrown in there too.

4. Content Licensing - 10%. Disney’s revenue from distributing their content to third party streamers (e.g. Amazon Prime) and cinemas (e.g. Cineworld).

Okay, so we’ve seen how these 4 segments contribute to revenues. Now, let’s look at how these 4 segments contribute in terms of profitability. And to whet your appetite, here’s the EBIT margins of the 4 segments in 2022!

So without further ado… !

Streaming

Let’s start with the least profitable segment for Disney - streaming. And let’s try and work out why this segment is loss making. The chart below shows us the costs in this segment.

And after seeing content costs make up 74% of Netflix’s costs last week. It’s probably no surprise to see content costs make up a large proportion of Disney’s streaming cost base too. Now, what do we mean by content costs? Well, as we saw yesterday, Disney are creating a lot of original content these days. And are starting to send smaller films and shows straight to Disney+. The costs to create this content would be found in content costs here.

But that’s not all! Because Disney+ isn’t the only platform in this segment. The other major platform for Disney is Hulu. And would you believe it, despite Hulu only being 20% of Disney’s total subscriber count. The platform makes up over 50% of Disney’s content costs in this segment!

But how is that possible? How can Hulu’s content costs be greater than Disney’s? Well, to answer that, we need to remember something we covered yesterday. Remember we talked about how pay-tv providers like Comcast have to pay networks like ESPN and Fox News to show their content? Well, in the case of Hulu’s live TV bundle, Hulu basically takes the place of the pay-tv provider! Hulu pays networks (like NBC and CBS) so its platform can show viewers content like Sunday Night Football or NCIS.

As we saw in the intro, Disney+’s investments in creating content. And Hulu’s investments to acquire content. Has led to this DTC (direct to consumer) segment lose money ever since it started. In fact, the $24bn costs we see in this segment is higher than the costs we see in any of the other 3 segments!

So, how long can Disney continue to make losses in this segment? Well in Feb, Disney’s returning CEO Bob Iger reiterated his view that the streaming segment would become profitable by the end of 2024.

And if Netflix’s business is used as a comparison, it’s easy to see how streaming could become profitable for Disney. Content costs for Disney’s streaming segment currently sits at 72% of revenues. We saw last week that Netflix’s content costs sat at 73% of revenues back in 2012. But as the company grew their revenues, these content costs dropped to 61% of revenues. And marketing and other costs also fell as a % of revenue. Mr Iger will be hoping for something similar at Disney!

Content Licensing

Alright, so that’s streaming. What about content licensing? What are the costs involved for Disney when they’re distributing their content to the likes of Amazon Prime and Cineworld? Well, the chart below shows us that, again, content costs are the majority of costs here!

So we saw Hulu was driving the high content costs in the first segment? What’s driving the high content costs here? Well, it’s the blockbuster films. The director of Avengers: Endgame and Avengers: Infinity Wars, Joe Russo, clarified last year that both of these films cost over $500m to make. EACH!

Now, what on earth is costing so much? Well, the cast! Robert Downey Jr, Scarlett Johansson and the gang do not come cheap! Whilst the actors and actresses all got paid around $20m for the Endgame film. The real money (and cost to Disney) comes in profit shares. Robert Downey Jr is reported to have taken 8% of Endgame’s profits. Now, given Endgame’s profits were around $700m, this meant Mr Downey Jr, took a handsome $55m bonus on top of his $20m ‘salary’!

The other main cost for Disney in this segment is marketing (which comes under SG&A). SG&A = Selling, General and Administrative by the way! Obviously, when a new Marvel film is released. Or when a new Avatar film is released. They’re not small, quiet affairs! TV ads, press conferences, billboards, posters on buses - you name it! Disney spend marketing dollars to build hype around their key franchises.

And, unlike with streaming, this segment hasn’t always been loss-making. In fact, in 2020 and 2021, EBIT margins were 10.5% and 7.7% respectively. However, as we noted yesterday, if we look at this segment in isolation, it would give us a false perspective. Even if this segment made no profits for Disney, and continued to be loss-making. It would still have huge value for Disney. And that’s because the Marvel, Avatar, and other key franchises show their real value in merchandise retail and Disney parks! More on this in a moment!

Linear Networks

Alright, now let’s move onto some segments that actually make some profits for Disney! The chart below shows us what the cost structure for Linear Networks is like.

And yes, you guessed it - content costs are again the major cost line!

So, we saw Hulu content acquisition was the main driver of content costs in the first segment. Robert Downey Jr and his friends’ salaries were strong drivers of content costs in the second segment. What’s driving content costs here? The answer is sports media rights. ESPN pays an absolutely extraordinary amount each year to secure the rights to show America’s favourite sports.

The network pays $2.7bn a year to the NFL (American Football league) so they can show ‘Monday Night Football’ on their channel. ESPN also pays $1.4bn a year to the NBA (basketball league) so that they can showcase Lebron James and co. on their channel. Even baseball fetches a pretty hefty amount with ESPN paying the MLB (baseball league) ~$550m a year to show just a handful of games.

Now, the reason ESPN is willing to spend such large amounts on these sports rights. Is because of the huge affiliate fees that ESPN charges Comcast and other pay-TV providers. As we say yesterday.

And the chart below shows how strong the margin for the Linear Networks segment is vs the previous two segments. Disney changed their reporting in 2020 and so we don’t have consistent segment reporting pre-2020 unfortunately! However, the margin for this Linear Networks division will likely have been ~30% pre 2020 too.

But hold on. Some of you, like me, may be wondering - how on Earth does this division command a 30% margin. When streaming and content licensing have such low margins? After all, the main cost in all 3 divisions is content costs. So what’s the difference?!

Well, the main difference in this division is that the content costs are more fixed. What do I mean by this? Well, as we said above, ESPN pays the NFL $2.7bn a year for 10 years to show their content. This is a fixed figure. However, the revenue that ESPN makes from this content is variable. ESPN raises the affiliate fee they charge pay-tv providers every year. And they increase the cost of their advertising slots every year too!

So, what about the Streaming segment? Well, in this segment, it’s kind of the other way around. Revenues are more fixed - Disney charge subscribers a set amount/month (obviously there are price increases, but not too often). And Disney has to continuously come up with new content to satisfy their subscribers. Their spending on content is very variable!

This cost-plus pricing we see in the Linear Network segment has allowed networks like ESPN to make outsized profits over the last few decades. Because the value to the end-customer has been a secondary factor vs network’s mark-ups. However, this is changing. And on Friday, we’ll look at how skinny bundles are squeezing margins in this division!

Disney Parks and Experiences

Alrighty, the final section! And finally, a segment where content costs aren’t involved! The chart below shows us that costs in the Parks and Experiences segment are more widely spread than in the previous segments.

The main cost in this segment is Labour. And if you’ve ever been to a Disneyland, you’ll know the number of people needed to keep those parks running! In fact, the 77,000 employees at the Walt Disney World resort in Florida makes this site the largest single-site employer in America!

The other big costs include infrastructure costs (maintaining the rollercoasters and machinery) and SG&A (marketing Disneyland to the world). If we include this segment in the margin chart below, we can see that Disney Parks and Experiences contributes strong profitability to Disney.

And one of the reasons why this segment has been able to achieve such strong margins (apart from the COVID years). Is the pricing power Disney has with their ticket prices and food and drinks! The chart below shows us how Disneyland California’s ticket prices have grown from $2.50 in 1955 to a whopping $129 now. This equates to 6% price rises per year for 60 years! Not bad!

Putting It All Together!

Okay, so we’ve seen the differences in profitability between Disney’s 4 segments. Linear Networks continues to be the most profitable segment with EBIT margins ~30%. But Streaming continues to be loss making for the company with Disney losing >$4bn in this segment in 2022.

What does this mean for Disney as a whole? Well, the chart below shows us that Disney is in unchartered territory at the moment. For nearly 20 years prior to the pandemic, Disney’s EBIT margin didn’t drop below 10% in even a single year. However, for the last 3 years, the company’s margin has remained below the 10% mark.

COVID hurt the margin in the Parks and Experiences segment (as parks were closed). And in the Content Licensing segment (as cinemas were shut). And the company’s move into Streaming, with the huge content investments, has also been a massive drag on profitability.

Can Disney’s margins continue to improve like we saw in 2022 - back to the pre-pandemic levels? Well, on Friday, we’ll really tuck into this question and analyse Disney’s future margin potential!

19th Apr 2023

Nigel Jacob CFA